quarterly market insight - centier bank · 2018-10-02 · index after tax earnings per share (eps)...

IN THIS ISSUE

SPOTLIGHT 2 ECONOMY 3

EQUITIES 5 FIXED INCOME 7

OUTLOOK 9 DISCLOSURES 12

QUARTERLY MARKET INSIGHT 1ST QUARTER 2017

SPOTLIGHT

CORPORATE TAX REFORM With the Republican Party controlling both houses of Congress and the White House broad-based corporate tax reform is looking like a serious possibility for the first time since the Tax Reform Act of 1986 during the Reagan administration There are several plans being discussed but the overall direction appears to be a reduction in the proportion of corporate profits subjected to federal taxes House Republicans have proposed a 20 maximum corporate tax rate while the Trump administration has recommended a 15 top rate Both represent a substantial reduction from the current maximum rate of 35 According to Goldman Sachs the median SampP 500 Index memberrsquos effective federal tax rate in 2016 was 24 Larger US companies with multinational sales are often better able than their smaller peers to capitalize on federal tax loopholes and indefinitely store foreign profits overseas Thus on average even a moderate reduction in the top rate could have a disproportionately positive effect on smaller-sized US companies than their larger counterparts

An analysis by Bloomberg Intelligence suggested the SampP 500 Index after tax earnings per share (EPS) could increase by 67 in 2018 if the US corporate tax rate is reduced to 20 assuming all other variables are unchanged The current median expectations for 2018 EPS growth is a healthy 121 but adjusting for a tax rate reduction to 20 would imply a 194 EPS growth rate The consumer discretionary utilities telecommunications and consumer staples sectors pay the highest effective tax rates suggesting that stocks in these sectors could be the biggest beneficiaries of corporate tax reform Specific industries within each of these sectors like department stores apparel retailers and footwear retailers may be positioned to benefit the most from corporate tax reform According to Bloomberg at least thirteen companies in these sectors paid an effective tax rate in 2016 of between 35 and 50 Major US carriers Verizon Inc ATampT Inc and T-Mobile Inc all paid taxes at an effective rate of at least 327 in 2016 All three would likely see improved after-tax profits in the event of a corporate tax rate reduction

Companies bringing cash back to the US could also stand to benefit from the proposals of a so-called ldquorepatriation holidayrdquo Republicans in the House of Congress target an 875 tax on accumulated foreign earnings brought back to the US in cash while the Trump administration proposes repatriation at a 10 rate According to Bloomberg SampP 500 Index companies hold $966 billion of cash overseas representing approximately 50 of the indexrsquos total market capitalization A significant portion of this cash is held by technology companies Apple Inc and

Microsoft Inc account for a combined 34 of all SampP 500 Index cash held outside the US More than a decade ago the repatriation holiday related to the Homeland Investment Act passed in 2004 led to SampP 500 companies bringing back about 40 of cash held abroad Some commentators have suggested that increased share buybacks and capital spending could result from a large-scale repatriation of corporate cash

The return of so much cash stateside could have a meaningful effect on trends in corporate bond issuance With more cash at their fingertips treasurers of US multinational companies would be likely to reduce issuance of corporate bonds thus reducing the supply of these assets In turn reduced supply and steady demand for corporate bonds could very well increase prices and tighten spreads for the broad corporate bond universe

Another potential aspect of broad-based tax reform that would affect the US bond market is interest payment deductibility Many commentators expect the Trump administration and House Republicans to propose removing the tax exemption on bond payments made by corporate issuers Currently US corporations have the right to deduct interest payments from taxable income This tax-exemption exclusion would likely be grandfathered in such that any debt issued before the prospective exclusion would still receive the tax benefit Going forward however any new debt would not benefit from the so-called ldquotax shelterrdquo enabling US corporations to reduce their taxable income by the amount of interest paid in a given calendar period For highly leveraged companies this could put significant pressure on profits For all corporations this would likely mean less debt issuance given the supply and demand landscape of the corporate bond market Just like the repatriation example less issuance combined with steady demand would most likely translate to increased prices and tighter spreads for the broad corporate bond universe

[page 2 Centier Bank | Quarterly Market Insights]

ECONOMY

SLOW UNSPECTACULAR GROWTH CONTINUES The positive momentum seen in the global economy in the fourth quarter carried over to the first quarter of 2017 as markets reacted favorably to stronger economic reports and increased corporate profits Fourth quarter US GDP growth was revised upward to an annualized rate of 21 beating expectations of 20 and up from the 19 initially reported The upward revision came in part due to increased spending on gasoline and travel-related services The biggest contributor however was consumer spending raised to 35 from 30 previously and an original estimate of just 25 Corporate profits increased again and rose by 93 in the second half of 2016 the fastest pace since 2012 Satisfied with the direction of the economy the Federal Reserve (Fed) raised interest rates in March as expected Fed officialsrsquo median interest rate projections indicate two additional 025 rate increases this year and three more next year

Multiple reports this quarter showed that the post-election increase in optimism among businesses and consumers remains strong The NFIB Small Business Optimism Index retreated slightly to 1053 in February but remained near an all-time high Small business optimism has increased sharply since the election as business owners anticipate beneficial policy changes from the new administration Another measure of business optimism the Business Roundtable CEO Economic Outlook Index jumped 191 points to 933 in the first quarter survey which was its largest quarterly increase since the fourth quarter of 2009 Consumer confidence blew away Februaryrsquos reading and economistsrsquo expectations coming in at 1256 This was roughly 10 points ahead of forecasts of 1140 and well above Februaryrsquos reading of 1161 Marchrsquos confidence number is the highest level in more than 16 years and continues a

ECONOMIC INDICATORS LATEST 3MO PRIOR CHANGE

REAL GDP 21 35

TRADE BALANCE -436 -455

UNEMPLOYMENT RATE 47 47

NON-FARM PAYROLLS 98K 155K

ISM MANUFACTURING 572 545

ISM NON-MANUFACTURING 552 566

RETAIL SALES (LESS AUTOS) 02 03

INDUSTRIAL PRODUCTION 01 -02

HOUSING STARTS 1288 1149

CONSUMER PRICE INDEX 27 17

CONSUMER CONFIDENCE 1256 1133

EXISTING HOME SALES 55M 56M

CONSUMER CREDIT 152B 255B

CRUDE OIL PRICE 506 5372

Source Bloomberg Past performance does not guarantee future results The change arrow is indicative of a positive or negative change in the economic nature of the data series For example a downward-pointing change arrow assigned to the crude oil price field will correspond with an increase in the actual price of crude oil over the last three months This is because a short-term increase in the price of crude oil has historically been detrimental to US economic growth

[Centier Bank | Quarterly Market Insights page 3]

ECONOMY CONTINUED

strong run since the election Surprisingly the boost was somewhat evenly dispersed across all household income levels and geographic regions Jobs expectations also improved as the number of consumers rating jobs as ldquoplentifulrdquo rose from 269 to 317 and ldquohard to getrdquo fell from 199 to 195

HOUSING The US housing market continues to show strength as the SampPCasendashShiller US National Home Price Index rose by 59 in January the largest increase in 31 months Much of this strength comes from a high demand for homes particularly in the western region as Seattle Portland and Denver all showed at least 90 gains over last year Also noteworthy in the west region were San Francisco home prices rising 63 in the last 12 months after overheating for a stretch Further underscoring the strength in demand Februaryrsquos pending home sales rose 55 compared to January marking the second highest level in more than a decade The combination of higher mortgage rates and housing prices could lead to a softer housing market as we move through 2017

EMPLOYMENT AND MANUFACTURING US employers hired workers at a strong pace in February as non-farm payrolls increased by 235000 jobs beating expectations of 200000 jobs The construction sector recorded its largest gain in roughly 10 years due to unseasonably warm weather Manufacturing jobs added 28000 while retail was a drag declining 26000 Additionally the December and January job reports were revised upward by 9000 Job gains have now averaged 209000 per month for the past three months Year-over-year wage growth rose to 28 driven by tight labor markets and minimum wage increases With the labor market close to full employment wage growth could be

pushed higher in coming months and quarters as companies attempt to retain employees and attract skilled workers Economists believe wage growth between 30-35 could lift inflation to the Fedrsquos preferred 2 target The official unemployment rate in February declined to 47 from 48 in January even as more people entered the labor market The labor force participation rate representing the share of working age Americans who are currently employed or looking for employment increased to 630

The ISM manufacturing PMI fell to 572 in March down from 577 in February The latest PMI reading remains comfortably over the 50 point mark that divides rising and falling activity levels ISMs New Orders Index registered 645 in March which is a decrease of 06 compared to the 651 reported for February indicating growth in new orders for the seventh consecutive month All 18 industries reported growth in new orders in March A decline in inventories at factories coupled with an increase in suppliersrsquo delivery time indicates increased demand in the sector and suggests momentum may sustain in coming months Further the backlog of orders index which registered 575 the strongest reading in three years also implies that healthy demand may continue in the near term The new export orders index improved to 590 which is the highest reading since November 2013 Strong growth in new exports orders suggests improving global demand and appears consistent with upbeat readings in global PMI Despite some cooling these indicators still remain elevated reflecting continued momentum in the manufacturing sector


EQUITY

THE BULL MARKET TURNS EIGHT Global stocks posted an impressive 70 return in the first quarter of 2017 against a backdrop of improving economic fundamentals across most of the world In the US the first three months of the year witnessed heightened levels of consumer and investor optimism This surge in domestic confidence notwithstanding international stock indexes outperformed their US counterparts in the first quarter led by key emerging markets including India Mexico and China In the US most of the first quarterrsquos gains occurred in the initial eight weeks of the period as the SampP 500 Index touched an all-time closing high on March 1 of 239596 The major US averages then spent March in consolidation mode Some of this consolidation was likely due to investors and traders awaiting the March Federal Reserve decision on interest rates Market participants seemed to be in wait-and-see mode in the weeks before the kickoff of first quarter earnings season It also appeared that some disillusionment bubbled to the surface concerning the speed and efficacy with which the Republican Party could implement the Trump administrationrsquos stated pro-growth policy objectives This became particularly evident following House Majority Speaker Paul Ryanrsquos decision to withdraw a GOP-sponsored bill designed to replace the Affordable Care Act after Republicans could not secure the necessary votes to pass the legislation

Although the US stock market hit a soft patch in recent weeks March marked an extraordinary milestone That is the bull market in US stocks which began in the depths of the Great Recession on March 9 2009 celebrated its eight-year anniversary this past quarter This is the second longest bull market on record spanning 2902 days during which the SampP 500 Index more than tripled in price terms from 683 to 2362 Our unofficial definition

of a bull market is a continuous period during which a market proxy (in this case the SampP 500 Index) does not suffer a 20 correction

Higher valuations have played just as big a role as earnings growth in the current bull market From the March 2009 low the SampP 500 has seen its ratio of price to trailing twelve-month earnings (PE ratio) expand from 111 to todayrsquos 217 multiple Meanwhile the SampP 500 aggregate EPS increased from approximately $5818 in 2009 to about $10859 in 2016 If we assigned the SampP 500rsquos 111 PE ratio from March 2009 to its 2016 earnings per share we would get an index level of just

SampP 500 INDEX EARNINGS AND VALUATIONS

$160 26

24$140

22 $120

20

$100 18

16$80

14 $60

12

$40 10

TRAILING 12M EPS (LS) TRAILING 12M PE RATIO (RS)

Source Bloomberg Past performance does not guarantee future results

2007

2007

2008

2009

2009

2010

2011

2011

2012

2013

2013

2014

2015

2015

2016

2017


EQUITY CONTINUED

120534 Thus we can infer that of the indexrsquos 1679 point ascent from March 2009 to March 2017 approximately 522 points (or 31) can be explained by earnings growth while the other 1157 points (or 69) can be attributed to an expansion of its PE ratio Earnings may be ready to take the baton however according to Bloomberg median analysts estimates SampP 500 earnings are expected to grow 187 in 2017 and 123 in 2018 This compares to actual growth of just 02 in 2016

Looking below the surface at the performance of US equities in the first quarter larger cap stocks beat their smaller cousins The SampP 500 index of large cap stocks returned just over 6 in the period compared to midcap stocksrsquo gains of just under 4 and small cap stocksrsquo returns of about 1 This was a reversal of the tilt towards smaller cap stocks that played out in the last part of 2016 and accelerated following the November election Explosive growth in the smaller cap stocks at the end of 2016 was attributed to the theory that smaller businesses had relatively more to gain from Trumprsquos tax reform agenda and that larger businesses (and therefore larger cap stocks) had greater vulnerability to the President-electrsquos plans for a more protective tariff scheme as bigger companies generally have more exposure to foreign trade The reversal of the returns distributions in the first quarter of 2017 reflects some increasing doubts about the new administrationrsquos ability to deliver on those legislative goals as well as some mean reversion of valuations after the big run up in the market

The same reversal played out in the style categories of growth versus value in the first quarter Value stocks indexes heavily weighted towards cyclical sectors like Financial Services and Industrials roared in late 2016 under hopes for a stronger overall economy and lsquoreflationrsquo Bank stocks in particular soared in late 2016 with the prospect

of higher interest rates boosting bank revenue led by a Fed unleashed to hike based on stronger economic data But that trend has reversed so far this year as the SampP 1500 Growth Index has returned just over 8 in contrast to the SampP 1500 Value Index which has turned in just above 3 The SampP Technology sector made up primarily of non-cyclical growth stocks with longer dated cash flows soared more than 12 in the first quarter with the NASDAQ index rising more than 10 Sectors more dependent on an increased level of widespread economic activity were left behind Industrials rose less than 5 year to date and Energy declined almost 7

Another reversal of leadership involves Emerging Market stocks Major market indexes in Brazil India and China all advanced at least 10 in the first quarter After several years of underperformance relative to domestic equities developing nationsrsquo stocks have led the way this year with the MSCI EM index posting well above 11 A stabilization of many emerging market currencies against the US dollar boosts the financial health of these economies many of which have issued dollar-denominated debt


FIXED INCOME

One of the more intriguing developments since the election of President Trump has been the large disparity between US interest rates and those of its European counterparts specifically Germany and the United Kingdom Currently the difference between 10-year rates in the US and Germany stands at 206 That is the eighth widest spread between the two rates dating back to January 1989 when Bloomberg began collecting data on the German 10-year rate At the end of the first quarter the difference between the US and the UKrsquos 10-year rates was 125 the widest yield advantage the US has had over the UK going back to January 1989 In fact each of the last five months falls into the top ten highest rate advantages the US has had over either of the two

1988

1991

1993

1995

1998

2000

2002

2005

2007

2009

2012

2014

2016

THE FED MOVES YIELDS DONT Last quarter we made the observation that the significant rise in intermediate rates that had occurred in the second half of the fourth quarter had likely brought US Treasury yields closer to fair value We also discussed the tradeoffs of investing in short-term fixed income or cash versus intermediate-term bonds Following up on that discussion investing in intermediate-term bonds as measured by the Bloomberg Barclays Intermediate Government Credit returned 078 during the first quarter In contrast the 1-3 year portion of the same index only returned 041 and a short Treasury index maintained by Bloomberg Barclays only returned 012 over the same time period The disparity in performance displays the risks of abandoning your stated objective for just one quarter

The US bond markets were relatively tame during the first quarter as the yields across the US Treasury curve traded in a very narrow range That said the curve did experience some flattening as shorter rates rose while longer rates edged ever so slightly lower Even with that flattening the curve remains steeper than average dating back to December 1979 The Merrill Lynch MOVE Index a measure of bond market volatility fell throughout the quarter as many market participants waited to see how the new President would implement his policy agenda and whether or not the Fed would hike rates Corporate spreads remained relatively tight as spreads on non-investment grade corporates tightened by 22 basis points All in all it was an uneventful quarter for the US bond market even as the FOMC hiked rates at their March meeting

DEVELOPED EUROPE AND US YIELD DIFFERENTIALS 1978 THROUGH MARCH 2017

14

12

10

8

6

4

2

0

-2

US 10-YEAR TREASURY YIELD GERMAN 10-YEAR BUND YIELD UK 10-YEAR GILT YIELD



FIXED INCOME CONTINUED

countries With US rates much higher than developed international rates an argument could be made that the interest rates will have to converge at some point Adding further credence to that argument is the fact that in all three of the aforementioned countries the most recent reports on inflation have shown that prices are rising at a pace not seen since at least 2014 While this suggests that developed international rates could potentially rise to meet US rates it is possible that US rates fall to achieve convergence In either likely scenario an overweight to US bonds would probably be preferred

With the Fedrsquos preferred measure of inflation Personal Consumption Expenditure Core Price Index (PCE) continuing to rise one more member of the FOMC believed that inflation risks were now tilted to the upside While the majority of the committee continues to hold the view that inflation risks are balanced between the upside and downside inflation expectations as measured by the University of Michigan Consumer Sentiment Survey remain around 25 over the next 12 months While the Fed uses a 5-year forward breakeven inflation rate from a working paper the correlation between the Consumer Sentiment inflation expectations and PCE 12 months later has been 087 since January 1978 suggesting that using such expectations might be helpful when trying to discern where inflation risks lie As of March the consumer sentiment survey shows that expectations for inflation over the next twelve months are 25 whereas the 5-year forward breakeven inflation rate stands at 195 The survey of inflation expectations also seems much more stable than the five-year forward breakevens which plummeted as the market reacted to Brexit

While the Fed does not appear to be behind the curve in hiking rates if consumer inflation expectations turn out to

be a better estimate of inflation a year from now then there is a risk that inflation starts to run away from the Fed and they are forced to aggressively hike to quell rapidly rising prices The implications of this occurring are covered in the Outlook section With that said two economists at the Federal Reserve Board have recently published a paper suggesting that central banks including the Fed may actually want to seek inflation in excess of their current two percent target That same paper also suggests that real interest rates are likely to be lower than they have been over the last half century Either way it appears that for the time being inflation should be a concern for bond investors

REALIZED INFLATION VS EXPECTED INFLATION 1978 THROUGH MARCH 2017

20

15

10

5

0

-5

PCE YOY

CPI YOY

INFLATION EXPECTATIONS 1 YEAR PRIOR -U OF MICHIGAN CONSUMER SENTIMENT SURVEY


1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017


OUTLOOK

INTEREST RATES RECESSIONS AND EQUITY RETURNS Compared to the equity rally that began in the middle of the fourth quarter the closing weeks of the first quarter could demonstrate that any election-inspired rally may be slowing A competing view is that the recent move in stocks can be more clearly understood in the rebound of corporate earnings that became clearly measurable during the earnings releases over this same period Finally after nearly a 20 rally in such a short time it may be only natural for equities to take a breather

Despite the leveling off in March our review of eight macroeconomic factors continues to indicate the economy still provides support for better-than-average equity returns It must be noted however that over the last several months the unemployment factor has reversed course several times and in the short run should not be depended upon for continued support Also with wage inflation being cited by the Federal Open Market Committee (FOMC) as a key factor in their latest decision to hike it would not be a surprise to see inflation turn against equities These indicators are updated monthly to help investors better gauge the near-term outlook for equities

STEEPNESS OF THE YIELD CURVE Under the guiding hand of Fed Chair Yellen the Fed raised the federal funds rate by a quarter of a percent without any significant reaction in bonds or stocks This marks the first time in her tenure as Fed Chair that an FOMC rate hike did not spook the market as evidenced by little to no change in the yield of the US 10-Year Treasury Note nor any 1 or greater intraday swing in the major equity indexes each of which happened near previous rate announcements

Why should investors care that a Fed hike failed to garner a reaction Our thinking is beyond the simple fact that their telegraphing finally worked Ever since previous Fed Chair Ben Bernanke spooked the markets in 2012 with the announcement that the Fed would begin to slow the pace of their monthly bond purchases the bond markets have exhibited higher volatility around rate announcements In their own words the ldquoFOMC seeks to explain its

monetary decision to the public as clearly as possiblerdquo1 If the bond prices behave erratically around FOMC announcement dates one might conclude they have not explained well enough

Throughout this economic expansion which began in June of 20092 investors have been concerned about the pace of rate hikes that would be required to prevent the next inflationary spiral especially since rates were cut to zero to stimulate the recovery in the first place The FOMC is very sensitive to the fact that inflation expectations have considerable influence over longer term interest rates set in the marketplace by investors Were the FOMC to hike too slowly and allow inflation a greater chance to take hold investors in longer term bonds would judge them as more risky curtail their purchases and long-term rates could rise Alternatively if the FOMC were to hike too quickly and stave off inflationary pressures before

ECONOMIC INDICATOR LATEST SIGNAL

FED FUNDS POLICY 100 BEAR

STEEPNESS OF YIELD CURVE 164 BULL

UNEMPLOYMENT RATE 470 BULL WTI OIL PRICE $5372 BEAR

SampP 500 INDEX 236272 BULL

SampPCASE SHILLER HOME PRICE INDEX 19281 BULL

PRODUCER PRICE INDEX 370 BULL

PHILADELPHIA FED SURVEY 3280 NEUTRAL

Source Bloomberg

1 httpswwwfederalreservegovfaqsmoney_12848htm 2 httpwwwnberorgcycleshtml


OUTLOOK CONTINUED

they had even begun to build investors in long-term bonds might become overly complacent and could potentially increase their purchases which could cause long-term rates to fall

The difference between longer term bond yields like the 10-year bond and the shortest T-Bill rates indicate the steepness of the yield curve When the yield curve is steep long rates are higher than short ones indicating longer term bond investors want extra compensation for inflation risks When short- and long-term rates are nearly the same the yield curve is called ldquoflatrdquo and if shorts are higher than longs it is ldquoinvertedrdquo Flat and inverted yield curves have occurred when inflation expectations are extremely low or even deflation is expected Historically when the yield curve flattens or inverts recessions have occurred within less than a year

The current worry would be for the FOMC to hike too aggressively causing the bond market to overreact to falling inflationary pressures eventually resulting in a flat or inverted yield curve The nearby chart shows the steepness of the yield curve over the past 40 years with recessions depicted by grey shading Though the current level of steepness is near the historical average it can be seen how it has become less steep over the past few years

This cycle has one key difference At present the Fed owns about $45 trillion in US government securities that were purchased through their quantitative easing (QE) programs Before the Fed began QE it was reported they owned only $700 billion in Treasuries Recent news reports indicate the Fed may begin to reduce these holdings towards the end of 2017 If QE reduced yields then selling these could increase them If the Fed hikes the short end of the yield curve while at the same time sells bonds in the long end of the curve they might actually prevent the yield curve from flattening providing a strong signal that the expansion can continue and along with it the current bull market for stocks

STEEPNESS OF THE YIELD CURVE 1971 THROUGH MARCH 2017

50

40

30

20

10

00

-10

-20

-30


1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015


ECONOMIC OUTLOOK

ECONOMIC FACTORS CURRENT OUTLOOK

US GDP Growth The median forecast for US GDP growth in 2017 is 22 as pro-growth policies may be slow to materialize

Federal Funds Rate The expectations for three quarter-point rate hikes in 2017 could be tempered if the Fed begins to unwind its balance sheet late this year

Inflation The Fedrsquos preferred inflation measure (core PCE) hit their target level in February climbing 21 YOY and clearing the way for additional rate hikes Employment Growth in both the labor participation rate and in wages should keep the unemployment rate near post-recession lows Consumer Confidence Sustained optimism for the implementation of pro-growth policies has consumer confidence at a 16-year high likely buoying risk asset prices

Oil OPECrsquos decision to cut output and rebalance the oil market should keep prices stable in 2017

Housing The housing recovery is likely to move slowly forward in 2017 as increased demand is offset by higher interest rates International Economies The IMF sees India and China driving global GDP growth in 2017

UNDERWEIGHT NEUTRAL OVERWEIGHT

FIXED INCOME CURRENT OUTLOOK

We suggest a neutral allocation to core investment grade bonds We recommend an underweightCore Bonds to below investment grade bonds as their spreads still appear compressed even as credit concerns

TIPS have dissipated International bonds currently have no place in our fixed income portfolios especially developed international where German 10-year rates are more than 2 lower than

Non-Investment Grade US rates Finally we advise an overweight to TIPs in an effort to provide protection against rising interest rates that will likely be driven by an escalation in inflation expectationsInternational

Benchmark BB BC Intermediate GovernmentCredit Index


EQUITIES CURRENT OUTLOOK

Large Cap

Mid Cap

Small Cap

Developed International

Emerging Markets


ALTERNATIVES

We believe an overweight to US equities relative to our benchmark remains appropriate given underlying domestic economic strength the likelihood that US multinationals will be able to repatriate overseas profits at favorable tax rates and potential economic and market volatility in the UK and euro zone in coming quarters Within our US allocation we view mid and small cap companies as better positioned to benefit from corporate tax reform and a stronger dollar than their large cap peers We continue to favor emerging market equities over developed market international equities against a backdrop of improving emerging market economic fundamentals and potential political disruptions related to upcoming elections in France and Germany

Benchmark MSCI All Country World Index (ACWI)

CURRENT OUTLOOK

CAP PRES IWSG BAL GWSI GROWTH

Given our expectation for increased periods of both equity and fixed income volatility in 2017 weGlobal Real Estate have moderately increased our weighting to alternative investments It is our view that both

Global Infrastructure equities and fixed income are approaching full valuation and the early policy implementation challenges for the Trump administration may have appreciably increased the likelihood of

Hedged Equity downside volatility In response we have constructed diversified alternatives portfolios meant to

Arbitrage decrease the risk profile of their respective recommended total AI portfolios which are listed to the left (CAP PRES IWSG BAL GWSI GROWTH)

Strategic Income

The above underweightneutraloverweight calls represent the MainStreet Advisors current positions relative to market weights Cap Pres Capital Preservation IWSG Income with some growth Bal Balanced GWSI Growth with some income The material is prepared and distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy The information presented has been obtained with care from sources believed to be reliable but is not guaranteed Opinions herein are not statements of facts and may include ldquoforward-looking statementsrdquo which may or may not be accurate over the long term Report includes candid statements and observations regarding investment strategies asset allocation individual securities and economic and market conditions Statements opinions or forecasts not guaranteed and are as of this date appearing only 41217 Do not place undue reliance on forward-looking statements Client accounts may not reflect the opinions expressed herein Investing involves risk and may result in loss This information is subject to change at any time based on market and other conditions Past performance is not indicative of future results which may vary

Centier Bank 600 East 84th Ave Merrillville IN 46410-6366 219-755-6110

The information and opinions expressed in the market review are not intended to constitute a recommendation to buy or sell any security or to offer advisory services by MainStreet Investment Advisors The securities and financial instruments described in document may not be suitable for you and not all strategies are appropriate at all times This review is not intended to be used as a general guide to investing or as a source of any specific investment recommendations and makes no implied or express recommendations concerning the manner in which any clientrsquos account should or would be handled as appropriate investment strategies depend upon the clientrsquos investment objectives The portfolio risk management process and the process of building efficient portfolios includes an effort to monitor and manage risk but should not be confused with and does not imply low or no risk The charts are for educational purposes only and should not be used to predict security prices or market levels Any suggestion of cause and effect or of the predictability of economic or investment cycles is unintentional This report should only be considered as a tool in any investment decision matrix and should not be used by itself to make investment decisions

Opinions expressed are only our current opinions or our opinions on the posting date Any graphs data or information in this review is considered reliably sourced but no representation is made that it is accurate or complete and should not be relied upon as such This information is subject to change at any time based on market and other conditions Our views and opinions expressed may include ldquoforward-looking statementsrdquo which may or may not be accurate over the long term This Market report includes candid statements and observations regarding investment strategies Sector allocations individual securities and economic and market conditions however there is no guarantee that these statements opinions or forecasts will prove to be correct Actual results could differ materially from those described in these forward-looking statements Diversification does not ensure a profit and may not protect against loss in declining markets

There are substantial risks involved with investing in Alternative Investments Alternative Investments represent speculative investments and involve a high degree of risk An investor could lose all or a substantial portion of hisher investment Investors must have the financial ability sophisticationexperience and willingness to bear the risks of an investment in an Alternative Investment

Traditional and Efficient Portfolio Statistics include various indices that are unmanaged and are a common measure of performance of their respective asset classes The indices are not available for direct investment Past performance is not indicative of future results which may vary The value of investments and the income derived from investments can go down as well as up Future returns are not guaranteed and a loss of principal may occur Investing for short periods may make losses more likely Any investments purchased or sold are not deposit accounts and are not endorsed by or insured by the Federal Deposit Insurance Corporation (FDIC) are not obligations of the Bank are not guaranteed by the Bank or any other entity and involve investment risk including possible loss of principal

NOT A NOT FDIC MAY LOSE NOT BANK DEPOSIT INSURED VALUE GUARANTEED

NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY

SPOTLIGHT

CORPORATE TAX REFORM With the Republican Party controlling both houses of Congress and the White House broad-based corporate tax reform is looking like a serious possibility for the first time since the Tax Reform Act of 1986 during the Reagan administration There are several plans being discussed but the overall direction appears to be a reduction in the proportion of corporate profits subjected to federal taxes House Republicans have proposed a 20 maximum corporate tax rate while the Trump administration has recommended a 15 top rate Both represent a substantial reduction from the current maximum rate of 35 According to Goldman Sachs the median SampP 500 Index memberrsquos effective federal tax rate in 2016 was 24 Larger US companies with multinational sales are often better able than their smaller peers to capitalize on federal tax loopholes and indefinitely store foreign profits overseas Thus on average even a moderate reduction in the top rate could have a disproportionately positive effect on smaller-sized US companies than their larger counterparts

An analysis by Bloomberg Intelligence suggested the SampP 500 Index after tax earnings per share (EPS) could increase by 67 in 2018 if the US corporate tax rate is reduced to 20 assuming all other variables are unchanged The current median expectations for 2018 EPS growth is a healthy 121 but adjusting for a tax rate reduction to 20 would imply a 194 EPS growth rate The consumer discretionary utilities telecommunications and consumer staples sectors pay the highest effective tax rates suggesting that stocks in these sectors could be the biggest beneficiaries of corporate tax reform Specific industries within each of these sectors like department stores apparel retailers and footwear retailers may be positioned to benefit the most from corporate tax reform According to Bloomberg at least thirteen companies in these sectors paid an effective tax rate in 2016 of between 35 and 50 Major US carriers Verizon Inc ATampT Inc and T-Mobile Inc all paid taxes at an effective rate of at least 327 in 2016 All three would likely see improved after-tax profits in the event of a corporate tax rate reduction

Companies bringing cash back to the US could also stand to benefit from the proposals of a so-called ldquorepatriation holidayrdquo Republicans in the House of Congress target an 875 tax on accumulated foreign earnings brought back to the US in cash while the Trump administration proposes repatriation at a 10 rate According to Bloomberg SampP 500 Index companies hold $966 billion of cash overseas representing approximately 50 of the indexrsquos total market capitalization A significant portion of this cash is held by technology companies Apple Inc and

Microsoft Inc account for a combined 34 of all SampP 500 Index cash held outside the US More than a decade ago the repatriation holiday related to the Homeland Investment Act passed in 2004 led to SampP 500 companies bringing back about 40 of cash held abroad Some commentators have suggested that increased share buybacks and capital spending could result from a large-scale repatriation of corporate cash

The return of so much cash stateside could have a meaningful effect on trends in corporate bond issuance With more cash at their fingertips treasurers of US multinational companies would be likely to reduce issuance of corporate bonds thus reducing the supply of these assets In turn reduced supply and steady demand for corporate bonds could very well increase prices and tighten spreads for the broad corporate bond universe

Another potential aspect of broad-based tax reform that would affect the US bond market is interest payment deductibility Many commentators expect the Trump administration and House Republicans to propose removing the tax exemption on bond payments made by corporate issuers Currently US corporations have the right to deduct interest payments from taxable income This tax-exemption exclusion would likely be grandfathered in such that any debt issued before the prospective exclusion would still receive the tax benefit Going forward however any new debt would not benefit from the so-called ldquotax shelterrdquo enabling US corporations to reduce their taxable income by the amount of interest paid in a given calendar period For highly leveraged companies this could put significant pressure on profits For all corporations this would likely mean less debt issuance given the supply and demand landscape of the corporate bond market Just like the repatriation example less issuance combined with steady demand would most likely translate to increased prices and tighter spreads for the broad corporate bond universe


ECONOMY




REAL GDP 21 35
















ECONOMY CONTINUED







EQUITY






$160 26

24$140

22 $120

20

$100 18

16$80

14 $60

12

$40 10



2007

2007

2008

2009

2009

2010

2011

2011

2012

2013

2013

2014

2015

2015

2016

2017


EQUITY CONTINUED







FIXED INCOME


1988

1991

1993

1995

1998

2000

2002

2005

2007

2009

2012

2014

2016




14

12

10

8

6

4

2

0

-2










20

15

10

5

0

-5

PCE YOY

CPI YOY



1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017


OUTLOOK















Source Bloomberg



OUTLOOK CONTINUED






50

40

30

20

10

00

-10

-20

-30


1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015


ECONOMIC OUTLOOK















Large Cap

Mid Cap

Small Cap


Emerging Markets


ALTERNATIVES



CURRENT OUTLOOK






Strategic Income









ECONOMY




REAL GDP 21 35
















ECONOMY CONTINUED







EQUITY






$160 26

24$140

22 $120

20

$100 18

16$80

14 $60

12

$40 10



2007

2007

2008

2009

2009

2010

2011

2011

2012

2013

2013

2014

2015

2015

2016

2017


EQUITY CONTINUED







FIXED INCOME


1988

1991

1993

1995

1998

2000

2002

2005

2007

2009

2012

2014

2016




14

12

10

8

6

4

2

0

-2










20

15

10

5

0

-5

PCE YOY

CPI YOY



1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017


OUTLOOK















Source Bloomberg



OUTLOOK CONTINUED






50

40

30

20

10

00

-10

-20

-30


1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015


ECONOMIC OUTLOOK















Large Cap

Mid Cap

Small Cap


Emerging Markets


ALTERNATIVES



CURRENT OUTLOOK






Strategic Income









ECONOMY CONTINUED







EQUITY






$160 26

24$140

22 $120

20

$100 18

16$80

14 $60

12

$40 10



2007

2007

2008

2009

2009

2010

2011

2011

2012

2013

2013

2014

2015

2015

2016

2017


EQUITY CONTINUED







FIXED INCOME


1988

1991

1993

1995

1998

2000

2002

2005

2007

2009

2012

2014

2016




14

12

10

8

6

4

2

0

-2










20

15

10

5

0

-5

PCE YOY

CPI YOY



1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017


OUTLOOK















Source Bloomberg



OUTLOOK CONTINUED






50

40

30

20

10

00

-10

-20

-30


1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015


ECONOMIC OUTLOOK















Large Cap

Mid Cap

Small Cap


Emerging Markets


ALTERNATIVES



CURRENT OUTLOOK






Strategic Income









EQUITY






$160 26

24$140

22 $120

20

$100 18

16$80

14 $60

12

$40 10



2007

2007

2008

2009

2009

2010

2011

2011

2012

2013

2013

2014

2015

2015

2016

2017


EQUITY CONTINUED







FIXED INCOME


1988

1991

1993

1995

1998

2000

2002

2005

2007

2009

2012

2014

2016




14

12

10

8

6

4

2

0

-2










20

15

10

5

0

-5

PCE YOY

CPI YOY



1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017


OUTLOOK















Source Bloomberg



OUTLOOK CONTINUED






50

40

30

20

10

00

-10

-20

-30


1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015


ECONOMIC OUTLOOK















Large Cap

Mid Cap

Small Cap


Emerging Markets


ALTERNATIVES



CURRENT OUTLOOK






Strategic Income









EQUITY CONTINUED







FIXED INCOME


1988

1991

1993

1995

1998

2000

2002

2005

2007

2009

2012

2014

2016




14

12

10

8

6

4

2

0

-2










20

15

10

5

0

-5

PCE YOY

CPI YOY



1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017


OUTLOOK















Source Bloomberg



OUTLOOK CONTINUED






50

40

30

20

10

00

-10

-20

-30


1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015


ECONOMIC OUTLOOK















Large Cap

Mid Cap

Small Cap


Emerging Markets


ALTERNATIVES



CURRENT OUTLOOK






Strategic Income









FIXED INCOME


1988

1991

1993

1995

1998

2000

2002

2005

2007

2009

2012

2014

2016




14

12

10

8

6

4

2

0

-2










20

15

10

5

0

-5

PCE YOY

CPI YOY



1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017


OUTLOOK















Source Bloomberg



OUTLOOK CONTINUED






50

40

30

20

10

00

-10

-20

-30


1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015


ECONOMIC OUTLOOK















Large Cap

Mid Cap

Small Cap


Emerging Markets


ALTERNATIVES



CURRENT OUTLOOK






Strategic Income















20

15

10

5

0

-5

PCE YOY

CPI YOY



1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

2017


OUTLOOK















Source Bloomberg



OUTLOOK CONTINUED






50

40

30

20

10

00

-10

-20

-30


1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015


ECONOMIC OUTLOOK















Large Cap

Mid Cap

Small Cap


Emerging Markets


ALTERNATIVES



CURRENT OUTLOOK






Strategic Income









OUTLOOK















Source Bloomberg



OUTLOOK CONTINUED






50

40

30

20

10

00

-10

-20

-30


1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015


ECONOMIC OUTLOOK















Large Cap

Mid Cap

Small Cap


Emerging Markets


ALTERNATIVES



CURRENT OUTLOOK






Strategic Income









OUTLOOK CONTINUED






50

40

30

20

10

00

-10

-20

-30


1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015


ECONOMIC OUTLOOK















Large Cap

Mid Cap

Small Cap


Emerging Markets


ALTERNATIVES



CURRENT OUTLOOK






Strategic Income









ECONOMIC OUTLOOK















Large Cap

Mid Cap

Small Cap


Emerging Markets


ALTERNATIVES



CURRENT OUTLOOK






Strategic Income









quarterly market insight - centier bank · 2018-10-02 · index after tax earnings per share (eps)...

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